Antitrust law is changing again. I refer specifically to the judicial interpretation of the U.S. antitrust statutes as limits on what a dominant firm can do in its marketing and pricing practices. A rather complicated body of precedent turns on the question of when a dominant firm become a ‘monopolizing’ firm.

Also important is an understanding of when aggressively low pricing by a dominant firm becomes ‘predatory’ pricing?

Answers to these questions have changed drastically over the century since passage of the Clayton Antitrust Act. One big shift took place beginning in the late 1940s, as the Supreme Court, filled with Roosevelt appointees, began employing the statutory language both of the Clayton Antitrust Act and of its successor, Robinson-Patman, very aggressively against dominant firms.

As the law developed, predatory pricing became something of a bogeyman for plaintiffs and the courts alike. Plaintiffs accused big corporations with deep pockets of cheating, locking in their dominance, by pricing too aggressively low. Even if a large firm was pricing above its own costs, its prices might be considered predatory if it could economize on those costs in ways that “mom and pop” can’t, as through volume discounts from manufacturers. A&P was once invoked as a bogeyman in discussions of pricing, in much the same way that Wal-Mart is today.

Of course, consumers benefit from price wars and lose out when price cutting as a practice is jurisprudentially discouraged. But the longer-term threat of monopoly, a monopoly that may become in time sufficiently entrenched to wipe out the initial consumer gains from the low prices by which it was created, is what dominated the minds of many lawyers and judges from the 1950s well into the 1970s. For convenience, we might call this state of mind the Areeda-Turner concern, after a much-cited law review article by Philip Areeda and Donald Turner published in 1975, which (as it turned out) was close to the close of this era.

Chicagoans Bring Change

By the time of the election of Ronald Reagan as president in 1980, there was broad consensus that the courts had gone too far, encouraged by such theorists as Phillip Areeda and Donald Turner, and a line of precursors, and that they had made themselves overly intrusive referees. In a cliché of the era, the courts were criticized for protecting “competitors” at the expense of actual “competition.” The intuition was codified by the “Chicago school” of antitrust thought, associated with the names of Robert Bork and Ward Bowman.

Considering specifically the issue of predatory pricing, the Chicagoans argued that a monopoly gained through such pricing could rarely if ever become sufficiently entrenched to justify the degree of suspicion that had come to surround low prices. At some point, they argued, this monopolist has to raise prices to well above those to which its consumers had become accustomed in order to try to make its losses back, and at that point the market is ripe for the entry of a new competitor, one prepared to take advantage of the discontent those price increases will generate. So a monopoly created by low prices should be self-terminating.

If there are barriers to the entry into markets of new competitors, such barriers as would delay the self-destruction of the monopoly, then rational public policy should address that more directly, should seek to lower those barriers. Even then (Chicagoans concluded) punishing low prices looks like a dubious idea from the point of view of consumer welfare.

More than ten years after Reagan’s first Presidential victory, Chicagoans were still racking up wins in the courts, notably in the Supreme Court decision of Brooke Group Ltd. V. Brown & Williamson (1993). This case arose out of rivalry at the generic or cut-rate end of the cigarette market, and out of an 18 month price war in 1984-85. The Court ruled in 1993 that B&W (the defendant, accused of predatory pricing by Brooke Group) was entitled to judgment as a matter of law. Although SCOTUS didn’t endorse any specific definition of predation here, it did say that pricing cannot be predatory unless it falls below “some measure of incremental cost.” What measure continues to be a matter of much debate.

The Latest Change

Now the tide may be moving out from Chicago. There may be a new consensus that, even if the Areeda-Turner vintage views went too far in one direction, the success of the Bork-Bowman view has brought us too far the other way, has made our legal system too welcoming to price competition that may in fact be adverse to the public good.

The recent Third Circuit decision in ZF MeritorMeritor v. EatonEaton is a case in point. Eaton Corp. (ETN) unsuccessfully petitioned the U.S. Supreme Court this year to review the 3d Circuit concerning conditional rebate agreements, a decision that went against it. Clearly there can’t be any very fundamental distinction between rebating on the one hand and price cutting on the other as marketing tactics. The Third Circuit decision and the high court’s willingness to let it stand, may have considerable significance for the future of antitrust law and the ground rules for marketing and pricing decisions.

A word about the scorecard: this case began as a lawsuit filed by Z.F. Meritor (a joint venture of Z.F. Friedrichshafen AG and Meritor Transmission Corp.) in 2006. One of those parents, Meritor Transmission, is itself a subsidiary of Meritor Inc. (MTOR). The lawsuit charged that Eaton had entered into long-term contracts with truck manufacturers of a sort that stifled competition in the North American truck transmissions market.

On the North American continent there are only four direct purchasers of heavy duty (HD) transmissions, among them Volvo GroupVolvo Group. Eaton long sold exclusively to all four of them, from the 1950s until 1989, thus monopolizing this market.

In 1989, Meritor entered the fray, offering manual transmissions for linehaul trucks, a subset of the HD market. By 1999, when Meritor transferred its transmissions business into the joint venture ZF Meritor, it had approximately 17 % of the market for HD as a whole, which was 30% of that for linehaul truck transmissions.

It was also at about the turn of the millennium that Eaton began entering into long-term contracts, for periods of at least five years, with its customers. These contracts included conditional rebates; that is, a customer would get a rebate only if it purchased from Eaton a specified share of its requirements. For example, Freightliner, which is now part of DaimlerDaimler AG, was promised a rebate if it purchased 92% of its requirements from Eaton. Eaton was successful in locking customers in with these deals, and Meritor shifted its own strategy away from the truck makers toward their customers, seeking to make sales of its transmissions directly to the owners of truck fleets.

Judge Fisher, who wrote the majority opinion for the 3d Circuit panel, observed that Meritor neither proved nor even attempted to prove that the rebate-adjusted prices Eaton offered its long-term customers fell below “an appropriate measure of its costs.” Yet Fisher, and Judge Oliver voting with him, denied that this put Eaton’s behavior in a safe harbor. Rather, they saw this as a different category of antitrust conduct, an “exclusive dealing” claim, in which the low prices/rebates served as bait.

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Much of what Mr. Falle says makes sense. Predatory pricing cases should be hard to bring, because the object of competition is to encourage price cutting. One way to interpret the current legal standard is that unless a price cut isn’t anticompetitive unless it could not be a response to competition under any scenario. That’s an appropriately tough test.

However, it doesn’t apply everywhere. Mr. Falle’s error–and he’s hardly alone–is where he says “Clearly there can’t be any very fundamental distinction between rebating on the one hand and price cutting on the other as marketing tactics.”

Actually, there is. In predation cases, the buyers are typically consumers, who aren’t competing with each other. In rebate cases, on the other hand, the buyers getting the rebate are typically competitors.

In the case of which he writes, the buyers are, I gather, truck manufacturers. When the buyers compete, the “fundamental distinction” is that pricing schemes could serve to suppress competition in an otherwise competitive buyers’ market, which they can’t do when the buyers are consumers.

Whether a rebate program actually suppresses competition sufficiently to raise antitrust concerns surely requires evidence on the effect of the programs on the degree of competition among the companies getting rebates, the opportunities for others to deal with those companies, and the presence of good substitutes among companies not getting the rebates. In the Eaton case–which I do not know well and, for the record, did not participate in–the issue would be whether competing transmission companies would be hamstrung by having no outlets for sale or only the ability to get their transmissions on inferior trucks.

These inquiries, however, do not and should not require the price-to-cost comparisons appropriate for determining predation. That’s the consequence of the missing “fundamental distinction”: whether or not the buyers have meaningful competition that could be suppressed.

You make an interesting point, and I expect that I’ll have a chance to address part of it in a forthcoming piece. As I indicated at the end of the above, I’m at work on a discussion of how the issues involved in EATON apply to the hospital-supply market. There, too, both the sellers and the buyers of supplies such as X-ray machines or tongue depressors act within the context of competition.

1. The Robinson-Patman Act was not a successor to the Clayton Act. It was an amendment which focuses on a narrow aspect of the much broader provisions of the Clayton Act – think treble damages and attorneys’ fees. 2. Yes, the pendulum had swung from Areeda-Turner’s big is bad to the Chicago School’s almost any unilateral business action is legal. That is the way of all social policy. It will swing back some at some point. 3. The “object” of competition is better stated as to provide customers with the best quality products and services at the lowest possible prices. 4. Rebating and price cutting are actually the same from the viewpoint that they are both price reductions or price discounts. However, rebating essentially presupposes an on-going relationship between a buyer and seller, where the seller offers a rebate (price discount/cut) based on the buyer’s purchases over some pre-defined period of time. Simple price cutting is a reduction offered to any willing buyer. 5. Except in the situation of a perishable product, a company cuts its prices to increase its sales and gain market share and must cut prices to do so because of competition. 6. The Eaton case presented the situation of a concentrated buyers’ market. This makes exclusive rebate contracts a potentially significant barrier to entry for new competitors. This is particularly true when the contracts are long-term and are not easily terminable (e.g., on 30 days notice). When the buyers’ market is un-concentrated a few exclusive contracts is less of a barrier. 7. Legal decision-making often gravitates to simple, clear rules that are easy to apply. Thus, the price-cost comparison is a useful tool. A price below total, fully allocated cost covers the marginal cost of the product/service and still contributes to the overhead which is valuable in the short run. However, a price below marginal cost does not cover the cost of making the product and raises some very real questions as what is the business purpose behind the practice – short term promotion to buy market share or longer term predation? 8. And, of course, there are all sorts of variations on the price discount scenario. Consider “bundling” which is not uncommon in the health care industry. Company A offer products A-1 through A-5. Company B only offers products B-1 and B-2. Company A allows the customers to buy any of its products separately but will offer a discount if a customer buys A-1 through A-5. Company B is at a disadvantage because it cannot offer the full range of products. In theory, to make the customer whole – all other things being equal – it must offer its products B-1 and B-2 at a low enough price – even if they are better than A-1 and A-2 – so that the customer can buy Company B’s products and products A-3, A-4 and A-5 at the undiscounted price and not have to pay more than the discounted bundled price for all 5 of A’s products. The Supreme Court has not weighed in on this issue yet but the lower courts have come up with different approaches to the issues.